5 Mistakes Investors Make When Buying Mutual Funds

Note: This article is courtesy of Iris.xyz

By Dana Anspach

With over 10,000 mutual funds, when you go to buy a mutual fund, where do you start?

Start by learning what NOT to do. You’ll keep more after tax income when you avoid these five mistakes when buying mutual funds.

Mistake #1 Chasing Past Performance

Pop finance magazines have to sell subscriptions and advertising – to do so they use headlines like “Top Ten Funds to Own This Year.” The editors and journalists do not know if these funds will make you money.

No one knows if these funds will make you money in the upcoming year. There are factors, however, that have been proven to deliver over time (and being on a top ten list is not one of them).

For example, Morningstar, a company that does research on mutual funds, notes that the single biggest predictor of top performing funds was not their own rating system of assigning stars, but the fund’s fees. Lower fees directly correlate with higher performing funds. Index funds have the lowest fees. Don’t buy high fee funds. Those fees are lining someone else’s pocket; not yours.

Mistake #2: Buying Funds With Embedded Capital Gains

Suppose you buy a mutual fund in October. In December that mutual fund sells a stock it has owned for ten years. A pro rata portion of that gain is then distributed to all current shareholders of the mutual fund. So now you are paying taxes on a gain that occurred within a fund that you have owned for only a short time. As a matter of fact, if the market has gone down, your shares may be worth less than what you paid for them, yet you will still be responsible for paying taxes on a portion of this capital gain.